Mid-term INTERNATIONAL FINANCE MANAGEMENT

Students are allowed to use the materials when doing the test. Students submit work on
LMS before 16h30 on Nov 24th, 2023

Student Name: Lê Trương Ngân Giang

MSSV: 31211023250

QUESTION 1 (01 POINTS): Restate the following one-, three-, and six-month outright
forward ($/1£) bid-ask quotes in forward points (forward swap rate).

Spot One-Month Three-Month Six-Month

1.3431-1.3436 1.3432-1.3442 1.3448-1.3463 1.3488-1.3508

Swap point Formula: s = | F(t, n) – S |

1 forward point = 10-4

Bid quotes in forward points Ask quotes in forward points

One-month 1 6
Three-month 17 27
Six-month 57 72

One-month s bid =| 1.3432 – 1.3431 | = 1 * 10-4 => 1 forward point

One-month s ask =| 1.3442 – 1.3436 | = 6 * 10-4 => 6 forward points
Three-month s bid =| 1.3448 – 1.3431 | = 17 * 10-4 => 17 forward points
Three-month s ask =| 1.3463 – 1.3436 | = 27 * 10-4 => 27 forward points
Six-month s bid =| 1.3488 – 1.3431 | = 57 * 10-4 => 57 forward points
Six-month s ask =| 1.3508 – 1.3436 | = 72 * 10-4 => 72 forward points

QUESTION 2 (03 POINTS): Student fill in the blank below and solve the problem

The 1-year deposit and lending interest rate in New York is 7%/year; in London is 3%/year.
Spot Rate 1GBP = USD 1.2430 - 1.2450
The 1 year forward rate 1GBP = USD 1.2610 – 1.2680

The price of GBP on a 1-year Future contract is 1GBP = USD 1.2640.

I.1. Should an American exporter who will receive £2 million within the next 1 year hedge this
payment by using a forward contract if this exporter makes decisions based on the theory of
interest rate parity (01 POINT).
 (1+iha)
Theory: We have the interest rate parity as following: Fb > Sa* = fa. If correct, the
(1+ifb)
company should hedge the payment using a forward contract.

Solution: Fb = 1.2610

(1+iha) 1+ 7 %
fa = Sa* = 1.2450 * = 1.2933
(1+ifb) 1+ 3 %

=> Fb < fa

=> Conclusion: The company should not hedge the payment using the forward contract as it will
not gain any foreign currency by selling foreign currency at forward rate.

I.2. Should an American importer who will pay £3 million within the next 1 year hedge this
payment by using a forward contract if this importer makes decisions based on the theory of
interest rate parity (01 POINT).

(1+i hb)
Theory: We have the interest rate parity as following: Fa < Sb* = fb. If correct, the
(1+if a)
company should hedge the payment using a forward contract.

Solution: Fa = 1.2680

(1+ihb ) 1+ 3 %
fb = Sb* = 1.2430 * = 1.1965
(1+ifa) 1+ 7 %

=> Fa > fb

=> Conclusion: The company should not hedge the payment using the forward contract as it will
not gain any foreign currency by selling foreign currency at forward rate.

I.3. Should an American importer who will pay £3 million within the next 1 year hedge this
payment with a Futures contract (The price of GBP on a 1-year Future contract is 1GBP = USD
1.2640)? (0.5 POINT).

If the American importer pay £3 million with the spot rate (1GBP = USD 1.2450), they have to
pay 3,000,000 * 1.2450 = 3,735,000 USD.

If the American importer pay £3 million with the price of GBP on a 1-year Future contract
(1GBP = USD 1.2640), they have to pay 3,000,000 * 1.2450 = 3,792,000 USD.

3,735,000 USD < 3,792,000 USD => Pay with spot rate < Pay with Future contract.
Conclusion: The American importer should not hedge this payment with Future contract, he or
she should pay £3 million with the spot rate.

I.4. Should an American exporter who will receive £2 million within the next 1 year hedge this
payment by using Futures contract if this exporter makes decisions based on a 1-year Future
price forecast of 1GBP = USD 1.2690. (0.5 POINT).

If the American exporter receive £2 million with the spot rate (1GBP = USD 1.2430), they will
receive 2,000,000 * 1.2430 = £2,486,000.

If the American exporter receive £2 million with the price of GBP on a 1-year Future contract
(1GBP = USD 1.2690), they will receive 2,000,000 * 1.2690 = £2,538,000.

£2,486,000 < £2,538,000 => Receive with spot rate < Receive with Future contract.

Conclusion: The American exporter should hedge this payment with Future contract with a price
of 1 GBP = USD 1.2690.

QUESTION 3 (03 POINTS): Student fill in the blank below and solve the problem

An investor is considering the purchase of five three-month Japanese yen call options with a
striking price of 96 cents per 100 yen. The premium is 1.7 cents per 100 yen. The spot price is
95.28 cents per 100 yen and the 90-day forward rate is 95.71 cents. The investor believes the yen
will appreciate to $1.00 per 100 yen over the next three months. As the investor’s assistant, you
have been asked to prepare the following:
1. Graph the call option cash flow schedule. (0.5 POINT).

2. Determine the investor’s profit if the yen appreciates to $1.00/100 yen. (0.5 POINT).
S(t) = $1.00/ 100 yen = 100 cents /100 yen

Striking price E = 96 cents / 100 yen

Premium price P = 1.7 cents / 100 yen

n=5

Contract size = 6250000 yen

We have S(t) > E, Profit = ( S(t) – E – P ) * V * n = (100 – 96 – 1.7) * 6250000 * 5 / 10000 =

$7187.5
3. Determine the investor’s profit if the yen only appreciates to the forward rate. (01 POINT).

Forward rate S(t) = 95.71 cents /100 yen

Striking price E = 96 cents / 100 yen

We have S(t) < E so we will not exercise the call options.

Therefore, we will have a loss of 1.7 cents/ 100 yen for our premium price.

Loss = - (1.7 * 5 * 6250000) / 10000 = $5312.5

4. Determine the future spot price at which the investor will only break even. (01 POINT).

Future spot price at which the investor will only break even: S(t) = E + P = 96 + 1.7 = 97.7 cents/
100 yen

QUESTION 4 (03 POINTS): Student fill in the blank below and solve the problem

Describe (01 POINT), make a payoff table (01 POINT) and draw a profit/loss graph (01
POINT) an optimal option strategy for an American exporter who will receive £3 million (which
needs to be hedged against foreign exchange risk) in case where GBP is forecast to decrease
sharply against USD.

Solution: An American exporter will receive 3 milion GBP in the next 7 months and the GBP is
forecasted to decrease sharply against USD. Therefore, the exporter should choose bear spread
strategy using put option (buying a put at a strike price and selling a ut with a lower strike price)
to hedge against foreign exchange risk.

PAYOFF TABLE OF BEAR SPREAD CREATED USING PUT OPTION

E1 < E2 => K1 < K2 S(t) < E1 < E2 E1 < S(t) < E2 S(t) > E2 > E1
(1) BUY1 PUT: E2, K2 (X): [E2 - S(t) - K2] (X): [E2 - S(t) - K2] (0): - K2
(2) SELL 1 PUT: E1, K1 (X): - [E1 - S(t) - K1] (0): + K1 (0): + K1
 BEAR = (1) + (2) [(E2 - E1) + (K1 - K2)] [E2 - S(t) + (K1 - K2)] (K1 - K2)

 S(t) < E1 < E2

[(E2 - E1) + (K1 - K2)] > 0 -> a positive constant => The profit will be maximized.
 E1 < S(t) < E2
[E2 - S(t) + (K1 - K2)]
y=ax + b
a= -1 < 0
b= E2 + (K1 - K2)
S(t) = E2 + (K1 - K2)
 The graph will go down.
 S(t) > E2 > E1
(K1 – K2) < 0 -> a negative constant => The loss will occur.

Suppose:
E1 = $1.5 / £
E2 = $2.5 / £
K1 = $0.1 / £
K2 = $0.3 / £

Contract size = £ 31,250

Because the exporter will receive 3 milion GBP in the upcoming 7 months, he or she has to buy:

3000000
= 96 (contracts)
31250

Calculation:
Buy put options:
S(t) < 1,5: [X] = (2.5 – S(t) – 0.3) * 31,250 * 96
1,5 < S(t) < 2,5: [X] = (2.5 – S(t) – 0.3) * 31,250 * 96
S(t) > 2,5: [0] = -0,3 * 31,250 * 96
Buy sell options:
S(t) < 1,5: [X] = - (1.5 – S(t) – 0.1) * 31,250 * 96
1,5 < S(t) < 2,5: [0] = 0.1 * 31,250 * 96
S(t) > 2,5: [0] = 0.1 * 31,250 * 96

Break-even price S(t) = E2 – (K1 + K2) = 2.5 – (0.1 + 0.3) = 2.1

Maximum profit = [(E2 - E1) + (K1 - K2)] * Contract size * Number of contracts = [(2.5 – 1.5) +
(0.1 – 0.3)] * 31,250 * 96 = 2,400,000
Maximum loss = (K1 – K2) * Contract size * Number of contracts = (0.1 – 0.3) * 31,250 * 96 = -
600,000

PAYOFF TABLE

S(t) Buy put options Sell put options Net Profit / Loss
1.15 +$3,150,000 -$750,000 +$2,400,000
1.30 +$2,700,000 -$300,000 +$2,400,000
1.45 +$2,250,000 +$150,000 +$2,400,000
1.60 +$2,490,000 +$300,000 +$2,790,000
1.85 +$1,800,000 +$300,000 +$2,100,000
2.10 +$300,000 +$300,000 +$600,000
2.35 -$450,000 +$300,000 -$150,000
2.60 -$900,000 +$300,000 -$600,000
2.75 -$900,000 +$300,000 -$600,000
2.90 -$900,000 +$300,000 -$600,000
3.05 -$900,000 +$300,000 -$600,000